Holding banking doomsayers accountable

by PlanMaestro

Third quarter 2010 earnings are out and with several banks revisiting one year lows you would think that the credit situation is getting worse. That is simply wrong.

The New York Times finally started following the story with its Friday’s article “Banks Start to Dig Out From Troubled Loans“. My only complain is the use of the word start, why journalists not only are late to stories but then downplay them. And do not take my word for it, the same New York Times printed a graph that shows troubled loans peaking almost a year ago.

Some will say that those numbers are still high but before you jump into conclusions let me make a couple of points.

First, the USA is not Japan

It took more than 10 years after the bubble burst for Japan non performing loans to peak at close to 10% of total loans and only then government pressures pushed banks to deal with the zombie keiretsu borrowers. In the US instead, non performing loans were recognized faster, peaking at 7% in less than 3 years. Not to mention that the Japanese real estate bubble was crazier with much higher loss severities. And even after all that, when the Japanese finally decided to deal with their issues the banking sector NPLs decreased rapidly and stock prices recovered.

The second point is that American banks are very well capitalized (equity plus reserves) to handle the non performing loans even at this high levels. For illustration purposes lets bring back our old tool the Texas Ratio courtesy of bankregdata.com updated for Q3 2010 that keeps improving from already manageable levels.

So what is going on. My impression is this just is another installment of the Fear of the Dark, Fear of Death series. Human beings do not react well to uncertainty and banks are part black box so it is easy to say “there are many things to worry about banks”. I have no problem with that, everyone is in his right to invoke the not-in-my-circle-of-competence amendment. What disturbs me is that it usually comes with a litany of measurable and testable arguments that when proven wrong are just simply set aside to be replaced by the next litany that justifies the preconceptions.

For example, in this blog we have been very sceptic of the Commercial Real Estate is the next shoe to drop argument. Has anyone care to see its recent performance, well here it is. Already in the third quarter of 2009 CRE NPLs hit the second derivative and are stabilizing at less than 5% of total CRE loans well below the real issues: mortgages and construction NPLs.

Do you feel the fear? That is Elizabeth Warren probably around February 2010 when it was already clear that things were improving on the CRE front. Lucky for us she is more of a analytical doomsayer so she tried to support her points of view with a congressional oversight panel report. And surprisingly, it is a very good report with very interesting data.

What made me skeptical of her conclusions was how easily she mixed and confused CRE construction and development loans, a real problem, with income producing CRE loans, a much smaller problem. Mixing both had the consequence of exaggerating the scale and scope of the problems.

As soon as one of the issues is proven wrong, the discussion moves to the new flavor of the month. Now the new issues are:

Europe: can somebody explain me the contagion mechanism, maybe not because there is no contagion mechanism this time.

Putbacks that even the worst loss estimate is less than one year of earnings

Foreclosure mess: that the banks badly mishandled. However, that has been usually the case in every real estate bubble in history and every time the banks managed to get their foreclosures.

Doomsayers sound smart and professorial but their ability to predict has been abysmal even for forecaster standards. Why? Partly because markets adapt, people adapt, and capitalist economies grow solving a lot of issues in the process. But hey, the bogeyman and hell are just around the corner.

I sometimes miss people like John Templeton and Peter Lynch in 1989, right in the middle of the S&L crisis, sharing their optimistic long term perspective while grounded in the difficulties of investing. They were not just smart but wise. Instead we are now at the end of the beginning for banks and these celebrities keep playing on our fears without checking their thinking and numbers.

I am not going to say that some of these issues could not become real, even data driven people like myself are susceptible to over confidence. I prefer to be detached with an open mind since banks are still somewhat opaque and their issues in other situations are real, just look at Ireland or some specific American banks like Flagstar Bancorp that is going through their third capital injection.

However, when you see one hit wonder celebrities that have been all wrong since October 2008 jumping to the new thing that confirms their preconceptions -and I think you know who I am talking about – take a pen, a napkin, run some numbers, but specially check the logical steps. Even with the more professional and less self promotional, like the excellent and bearish Chris Whalen, you should do so because there is no substitute to thinking independently and thinking correctly.

By the way, I found this video by Sir John Templeton right after the crash of October 1987. Besides being a fantastic video I was struck by the fact he said US GDP will grow 64 times in 40 years from 1987. That would mean a GDP of 256 trillion by 2027. I had to listen to the minute 9th of the video 5 times to make sure that was what he said.

The reason I could not be skeptical it’s because he said it would double in 10 years (and it did… or close to, from 4.7 trillions to 8.25 trillions) and then almost double again from 1997 to 2007 (from 8.25 trillions to almost 15 trillions). At another video he said GDP would be roughly 4 times in 20 years (1987-2007). Correct again!

So if he was SO correct 20 years in advance, even as incredible as it sounds, he might be correct in his astonishing pronouncement of a gigantic GDP in another 20 years. Think where market indexes will be with a 256 trillion GDP… DOW 36,000 will be cut through like butter.

[…] PlanMaestro More good news in the commercial real estate front. Bloomberg not only mentions the stabilization in bank CRE loans that we discussed a couple of days ago. U.S. commercial real estate loan delinquencies and default rates continued to march toward new […]

One thing I don’t understand is why we are having mild deflations now instead of inflation or hyper inflation. Obama printed 800 Billion in 2008 and is talking about quantitative easing for another 600 Billion. Will we have hyper inflation pretty soon?

From your post I can see that Japanese banks are doing well in a mild deflation environment. What will happen when banks are in an inflation environment when interest rate keeps rising? I think that is bad for the banks because their loans are 30 year fixed rate, but funding cost kept rising all the time, reducing their yield.

Zehua, this is not a macroeconomics blog so I am not the most proper person to answer you that. However, take into account $600B is a drop in the bucket and that when leverage goes down, the velocity of money also goes down.

Plan’s answer aside (when it comes) I will bite, although I think your inquiry is a little too complex.

Hyperinflation is the side effect of currency debasement, a point in which “coin” loses most of its “store of value” capacity and reflects no more trust in the system. The fact that other equally important currencies are showing weaknesses (i.e. euro), it slows the debasement of the dollar. Similarly, if interest rates rise as a consequence of players envisioning strong growth ahead the financial system in general will cope with it and the dollar will tend to appreciate instead. Whereas if interest rates rise as a consequence of an impossibility to fund future debt (revolving), all hell may break lose.

From now on, the game will be for those who can read the tea leaves the best. I am on the camp that we are seeing the seeds of a long term bull market worldwide with some scary bumps. But just in case I have left some room to maneuver if an implosion happens.

Politicos will probably defuse North Korea. Or there may be a quick, *clean* war that extends to neutralizing Iran. And many of the world tensions will come to pass. Just one hypothesis…